I am an attorney (www.lewissaret.com) practicing in the area of federal taxation, with particular emphasis on estate and business succession planning, based in the Washington DC metropolitan area. In addition, I am Chair and former Vice-Chair of the Fiduciary Income Tax Committee of the American Bar Association Section of Taxation. In the past, I have also served as Vice-Chair or Chair on a number of committees including the Asset Protection Planning Committee of the Real Property, Probate and Trust Section of the ABA. I am a prolific author and frequent speaker on tax and estate planning issues, co-authoring numerous books including Asset Protection Strategies: Tax and Legal Aspects and Valuation of Closely HeldBusinesses: Tax and Legal Aspects. I am also the co-founder of the Wealth Strategies Journal, an online journal pioneering to provide quality wealth management guidance available to the general public.

Obama's Budget Proposal: The Impact On Estate Planning Tools

A couple weeks ago on April 10, President Obama released his budget proposal for 2014. Although the proposal largely focused on areas such as military spending, education, Social Security and health care, hidden between the lines of the 244 page document were some important implications for estate planning. In particular, the new budget proposal targets various estate planning tools utilized by taxpayers in an effort to limit tax loopholes and generate revenue. Some of the estate planning tools that were mentioned in budget proposal are outlined below.

Cap on Retirement Accounts

Perhaps as a response to the discovery of some unconventionally large retirement accounts, one of the most important provisions in President Obama’s 2014 budget proposal is a new cap on retirement accounts. According to the proposed budget plan, taxpayers will not be allowed to accumulate more than $3 million in an individual retirement account. Although for the average taxpayer who’s IRAs would not be affected by this cap, for some this could have a significant impact on their IRA estate planning. In addition, it is unclear how this cap will be enforced or administered, and many predict that implementing such a provision will be difficult.

Estate Tax Changes

The new budget plan also proposes to change the estate tax by (1) increasing the estate tax rate from 40% to 45% and lowering the per-person estate tax exemption from $5.25 million to $3.5 million. Although these increases may not seem substantial, since the estate tax exemption threshold is still fairly high, the budget doesn’t state that the estate tax exemption amount will be indexed for inflation. This means that down the road as inflation increases the amount of money taxpayers may place in their estates, a greater number of smaller estates would also be subject to the estate tax rate. This could cause them to lose nearly half of their savings in these estates to taxes.

Generation Skipping Transfer Tax-exempt Dynasty Trust

GST tax-exempt dynasty trusts are a unique type of irrevocable trust that has a $5.25 million exemption from the generation skipping transfer tax. Basically, this means a taxpayer can pass on wealth generated from assets that appreciate in the trust to beneficiaries, generations later. Since GST tax-exempt dynasty trusts are in essence perpetuities with no definite end, they can be an attractive estate planning tool. The new budget plan, however, proposes limiting the existence of a dynasty trust to 90 years. Although this may still be an attractive and appropriate estate planning tool, taxpayers planning on utilizing these trusts indefinitely may need to reexamine their estate planning strategies.

Grantor Retained Annuity Trusts

Grantor retained annuities trusts are also subject to changes under the new budget plan. Grantor retained annuity trusts, which are typically short term trusts composed of quickly appreciating assets, are trusts that retain an income interest that is received as an annuity payment. The gift tax is determined at the beginning of the trust term and appreciated value is distributed to the beneficiaries without additional taxes if the taxpayer is still alive at the end of the trust term. This is an attractive estate planning tool since it allows taxpayers to minimize transfer taxes while still distributing to beneficiaries. However, the new budget plan would potentially eliminate this type of trust’s attractiveness by requiring a minimum trust term of 10 years, thus increasing the possibility that the grantor would pass away, passing the trust assets to his or her estate for estate tax purposes and not the beneficiaries.

Intentionally Defective Grantor Trusts

IDGTs are a special type of grantor trust where the trust is a separate entity from the taxpayer and allows the taxpayer to exclude some of his or her taxable estate, but is not treated as a separate entity for tax purposes. This means the taxpayer is paying income taxes on the appreciated assets in the trust, allowing more value to be distributed to beneficiaries. The proposed budget eliminates this tax separation, requiring instead that a gift tax be paid upon distribution from the IDGT and all value would be considered part of the estate for estate tax purposes when the grantor passes away. Since the purpose of IDGTs is to minimize the taxable estate while increasing amount distributable to beneficiaries, this new proposal would eliminate the value to using IDGTs as an estate planning strategy.

These are only some of the many ways the new proposed budget could affect estate planning tools. One thing is for sure, however: taxpayers who are looking into or currently using these forms as part of their estate planning strategy should be on alert as change seems impending on the horizon.

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